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Frank & Bernanke 3rd edition, 2007 Ch. 5: Measuring Economic Activity: GDP and Unemployment 1 Why Measure A Nation’s Income To have a sense of an economy’s size. The well being of a citizen, on average, depends on the nation’s income and its population. As the income of the society increases, the average person will have a higher standard of living. One can drown in a lake of 3-ft average depth. Standard of living may not necessarily be the goods and services a household can consume. 2 Definition of GDP Gross Domestic Product is the market value of all the final goods and services produced within a country in a year. How do you determine the value of child care? How do you include the production of steel or plastics? How do you include the sales of existing homes? How do you account for $4 million paid at an auction for a Van Gogh painting? How do you account for government services? 3 Market Value Suppose we live in an economy where only hamburgers, colas and cookies are produced. Prices are: hamburgers $2; colas $1; cookies $0.50. If this economy produces 100 hamburgers, 150 colas and 200 cookies, what is the market value? What is the market value if 200 hamburgers, 100 colas and 100 cookies are produced? 4 Percentages of American Men and Women over Age 16 Working Outside the Home • Increase in female labor force participation increases the demand for housekeeping and child care. • Unpaid household work is not counted in GDP. • Paid household work is counted in GDP. • The increase in female labor force participation has overstated GDP growth. 5 Gross Domestic Product: Measuring the Nation’s Output Economic Naturalist Why has female participation in the labor market increased by so much? What explains the trends illustrated in the previous figure? Hint: The concept of comparative advantage 6 Why GDP Is Equal to Income? How is my contribution to the US economy calculated? The amount of educational service I create is equal to my gross income. How is the income of a real estate agent calculated? When she sells a 25-yr old house, she gets a percent of the price as a payment for her services. 7 Why GDP Is Equal to Income? How is the GDP contribution of the textbook company calculated? After they pay the author, the paper company and the ink company, the amount of revenue they get from textbook sales plus the value of their book inventory (unsold books) is their contribution to the US GDP. Their contribution is equal to wages, salaries, rent, interest and profits they pay. 8 Value Added Calculate the contribution of the following activities to GDP. Farmer sells cotton for $100. Cotton is processed into thread and sold for $130. Thread is made into cloth and sold for $200. Cloth is made into shirts and sold for $300. 9 Circular Flow Consumption expenditures of households Firms Households Income (wages, salaries, rent, interest, profit) earned by households 10 Circular Flow Upper flow is equal to GDP. Lower flow is equal to income. If GDP < Income, businesses will reduce production and create less income. If GDP > Income, businesses will want to expand production and create more income. 11 12 How Can We Measure GDP? Expenditure Approach: the upper flow. Y = C + I + G + NX Income Approach: the lower flow. Y = Sum of factor incomes Y = Wages + Salaries + Rent + Interest + Profits 13 Components of Expenditure Approach Consumption includes spending on food, entertainment, shelter, health care, transportation, clothing, household items, insurance, education. 14 Components of Expenditure Approach Investment includes purchases made by firms to generate future income. Machinery, tools, buildings, trucks and cars are part of investment if they are bought to generate future income. By convention, newly built houses and inventory are included under investment. 15 Components of Expenditure Approach Government purchases are expenditures of federal, state and local governments on goods and services plus their payrolls. 16 Components of Expenditure Approach Net exports is exports minus imports. Dell Computer sales in China are part of US exports. Dell Computer purchases of plastic molds for their computers from China are part of US imports. 17 GDP http://www.bea.gov/bea/dn/nipaweb/TableView.asp#Mid 18 Labor and Capital Income Source: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=economic_indicators&docid=05de01.txt 19 The Three Faces of GDP Production Market value of final goods and services Expenditure Income Consumption Labor Income = = = = Investment Government purchases Capital Income Net exports 20 A GDP Increase Always Increases The Size of the Economy WRONG! What if GDP in 2005 were 1000, in 2006 were 1500 but inflation was 50%? In this case, the increase in GDP is solely attributable to price increases, not improving the well being (standard of living) of the average citizen. 21 Nominal vs. Real Measures In macroeconomics, most variables are measured in real terms, not nominal terms. Real variable eliminates the effect of inflation. Nominal variable includes the effect of inflation. GDP comparisons are always made with real GDP. Nominal GDP uses current prices. Real GDP uses base year prices. 22 Real and Nominal GDP The Economy Produces 2 Goods: Pizza and Soda Year 1997 1998 1999 Pp 10 11 13 Qp Ps 1000 2 1000 3 1200 4 Qs Nominal GDP 5000 $20,000.00 6000 $29,000.00 7000 $43,600.00 Real GDP GDP Deflator $20,000.00 100.0 $22,000.00 131.8 $26,000.00 167.7 Nominal GDP is calculated by adding the amounts spent on each Product. Real GDP is calculated by using the prices of pizza and Soda from 1997 o calculate the amounts spent in future years. GDP Deflator is Nominal GDP/Real GDP. 23 Real and Nominal GDP 24 What Is Wrong With Real GDP? Real GDP increases if you sell your services rather than provide them free. If you build a house through Habitat for Humanity your work doesn’t count as part of GDP. If you get paid for the same work, it counts. If you pollute during production and someone pays to clean the environment, the GDP will be higher than if the producer tried to reduce pollution during production so no clean-up was necessary. 25 Underground Economy If market transactions cannot be tracked by data collectors, they may be ignored. Transactions with high cash usage and no paper trail can remain hidden from the government. GDP may actually be much higher than government statistics if there is a large underground economy. 26 Real GDP is not the Same as Economic Well-Being Leisure Time Shorter work week Start working later Retire earlier 27 Real GDP is not the Same as Economic Well-Being Nonmarket Economic Activities Household production Volunteer services Nonmarket activities are more important in poor countries Underground economy 28 Real GDP is not the Same as Economic Well-Being Environmental Quality and Resource Depletion Benefits of environment quality are not measured. GDP is not adjusted for resource depletion. 29 Real GDP is not the Same as Economic Well-Being Quality of Life Crime rates Traffic congestion Civic organizations Open space 30 Real GDP is not the Same as Economic Well-Being Poverty and Economic Inequality GDP does not capture the effects of income inequality 31 GDP & Basic Indicators of Well-Being All developing countries Least developed countries GDP per person (U.S. dollars) 3,530 1,170 25,860 Life expectancy at birth (years) 64.5 51.7 78.0 Infant mortality rate (per 1,000 live births) 61 100 6 Under-5 mortality rate (per 1,000 live births) 89 159 6 Doctors (per 100,000 people) 78 30 252 Incidence of HIV/Aids (% in 15-49 age group) 1.3 4.3 0.3 Undernourished people (%) 18 38 Negligible Primary enrollment rate (as % of age group) 85.7 60.4 99.9 Secondary enrollment rate (as % of age group) 60.4 31.2 96.2 Adult literacy rate (%) 72.9 51.7 98.6 Indicator Industrialized countries 32 http://hdr.undp.org/hdr2006/statistics/ 33 How Does the Government Measure Unemployment? • Bureau of Labor Statistics (Department of Labor) collects information every month. • The first Friday of every month at 8:30 AM eastern time, the unemployment rate for the previous month is announced. • People of age 16 and older are classified as either EMPLOYED or UNEMPLOYED or NOT IN THE LABOR FORCE. 34 How Does the Government Measure Unemployment? • Employed – Any one working for pay. – It may be full-time or part-time. • Unemployed – Temporary lay-off. – Waiting to start a job. – Looking for a job. • Not in the labor force – – – – Retirees Students Homemakers Inmates 35 The Unemployment Rate Measuring Unemployment Labor force = employed + unemployed unemployed Unemployme nt rate labor force labor force Participation rate population 16 and over 36 U.S. Employment Data, July 2002 (in millions) Employed 134.04 Plus: Unemployed Equals: Labor force 8.35 142.39 Plus: Not in labor force 71.63 Equals: Working-age (over 16) population 214.02 Unemployment rate = unemployed/labor force = 8.35/142.39 = 5.9% Participation rate = labor force/working-age population = 142.39/214.02 = 66.5% 37 http://stats.bls.gov/news.release/empsit.nr0.htm 38 http://data.bls.gov/PDQ/servlet/SurveyOutputServlet 39 The Unemployment Rate The Cost of Unemployment Economic Psychological Social 40 The Unemployment Rate The Duration of Unemployment The impact of unemployment is influenced by how long individuals have been unemployed. The unemployment spell The duration of unemployment Long-term unemployed Chronically unemployed 41 The Unemployment Rate Unemployment Spell A period during which an individual is continuously unemployed Duration The length of an unemployment spell 42 The Unemployment Rate The Duration of Unemployment Discouraged workers Involuntary part-time workers In July 2002: Official unemployment rate = 5.9% Including discouraged workers and involuntary part-time worker = 9.4% 43 The Unemployment Rate Discouraged Workers People who say they would like to have a job but have not made an effort to find one in the last four weeks 44